The Lending Limit Conundrum

As the saying goes, when a market opportunity presents itself, business will react to take advantage of it. Federal Reverse Chairman Ben Bernanke is counting on this theory to hold true if lending limits are allowed to drop on October 1, 2011.

The Federal Government has been seeking ways to reduce their footprint in the mortgage finance arena, but concerns abound whether the private market for non-agency mortgages is prepared to absorb the void left if the lending limit increase extension is allowed to expire. Without Congressional action, the maximum lending limit in high cost areas will drop from $729,750 to $625,500. The lending limit for HECM loans would fall from $625,000 to $417,000.

Bernanke believes the private market is prepared to seize the opportunity created by lower lending limits. "As far as Fannie Mae and Freddie Mac are concerned, there is a tradeoff there between supporting the higher priced homes and weaning the housing finance system off of unusual limits it was put under during the crisis," Bernanke said. "I understand the private sector is taking at least a significant number of the jumbo mortgage market but at a higher cost."

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The National Association of Home Builders have warned that allowing the lending limits to drop would make 17 million homes in the U.S. ineligible for the federal mortgage programs. With housing continuing to be weak and concerns about the private market's willingness to jump back in, some raise concerns about the timing the change.

In introducing H.R. 2508, The Conforming Loan Limits Extension Act, Representatives John Campbell (R-CA) and Gary Ackerman (D-NY) are calling for current lending limits to be extended for another two years. It is not clear whether the temporary extension would include lending limits for HECM loans.

"Reducing the conforming loan limit would hurt home values, increase the cost of down payments and interest rates, and shut prospective buyers out of home ownership." Rep. Ackerman said. "It is essential that we continue to do all that we can to stimulate our economy and keep these mortgage limits in place to ensure that the housing market remains on the delicate road to recovery.”

Campell added, "H.R. 2508, the Conforming Loan Limits Extension Act, will ensure that qualified homebuyers in this country continue to have access to the financing they need at a time when there are few alternatives. This will not only help to stabilize home prices, but would also provide for continued recovery in the broader economy.”

However, the bill was introduced at a time when the House Financial Services Committee has been focused on finding ways to reduce the size of the government's involvement in the housing finance market and the White House has released a white paper suggesting the method for winding down Fannie Mae and Freddie Mac. The first step to accomplishing these goals would be to allow lending limits to revert back to pre-2008 levels - and the government can do that by taking no action at all.

The situation becomes a chicken and egg conundrum for the Federal government. In order to achieve the goal of reducing the size of the GSE's, they must be able to count on a robust private market for residential mortgages, or risk a further collapse of the market. Does the government act first and count on private market to seize the market opportunity created, or does the government continue to prop up a weak market waiting for more definitive signs of market recovery?